## _041612

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### I. Introduction and purpose
- Context: global financial crisis and recent commodity price spikes highlighted LICs’ vulnerability to volatile external financing flows and sharp swings in the terms-of-trade.
- Financial deepening defined as a multidimensional process increasing efficiency, depth, breadth, and reach (Goyal et al., 2011).
- Surveillance gaps identified:
  - Bilateral surveillance often focuses narrowly on banking soundness and solvency.
  - Comprehensive data on multiple dimensions of LIC financial systems are often missing.
  - FSAPs are low frequency and constrained by evolving LIC financial structures.
  - World Bank work on financial development insufficiently leveraged in macro policy advice.
- Paper objectives:
  - Widen financial sector surveillance lens in LICs to understand limits to policy implementation posed by shallow and undiversified financial systems.
  - Draw implications for analytical and operational issues; distill policy lessons from country experiences increasing depth, breadth, and reach.
  - Provide a new IMF-World Bank macro-financial data portal for LICs to encapsulate available information on multiple dimensions of LIC financial systems.

### II. Motivation: challenges posed by shallow markets
- Core macro-financial concerns:
  - Underdeveloped financial systems provide inadequate shock absorption, amplify vulnerabilities from external shocks, and hamper growth and poverty reduction.
  - Shallow systems constrain policy instruments, impede risk transfer, and create adverse macro-financial feedback loops.
- Empirical patterns and market integration:
  - New empirical analysis points to a U-shaped effect of financial depth on macroeconomic volatility, with depth amplifying volatility at very high levels beyond most LICs—implying scope for further deepening.
  - Average de facto financial globalization (gross external assets and liabilities) has increased six-fold since the mid-1980s, led by the “frontier markets.”
  - Example frontier markets include Mozambique, Senegal, Uganda, Tanzania, Bangladesh, Cote d'Ivoire, Ghana, Kenya, Nigeria, Vietnam, and Zambia.
- Policy-framework constraints and transmission channels:
  - Financial underdevelopment associated with higher likelihood of adopting fixed exchange rate regimes; de facto regimes in LICs remain less flexible compared to EMs.
  - LICs more likely to use direct monetary instruments and rely on reserve requirements and statutory liquidity ratios.
  - Thin domestic debt markets and variable foreign financing reduce fiscal policy room; fiscal policy tends to be more pro-cyclical in underdeveloped systems.
- Financial stability implications:
  - Limited availability of currency forwards and hedges increases foreign currency risk and credit risk from currency mismatches.
  - Thin domestic money markets raise banks’ liquidity adjustment costs, contributing to high liquid asset holdings and shorter asset maturities.
  - Narrow range of formal actors concentrates exposures, amplifying credit and interest rate risks.
- Macro-financial interaction with capital flows:
  - Shallower markets have lower capacity to absorb inflows without large asset price and real exchange rate changes and can contribute to boom-bust cycles in credit and investment.

### III. Stylized facts on recent patterns in deepening
- Financial structure and ownership:
  - Many LIC banking systems shifted toward privately-owned systems often controlled by foreign banks; foreign bank penetration has more than doubled for the median LIC since 1995, particularly in SSA.
  - The banking system continues to account for over 80 percent of financial system assets in the median LIC.
- Trends and indicators:
  - Median growth of credit to the private sector in LICs has doubled since the mid-1990s.
  - Deposit mobilization has grown faster than credit, resulting in declining loan-to-deposit ratios.
  - Interest margins and spreads have declined since the mid-1990s but remain wide relative to EMs.
  - Banks offer more basic payment and credit services; maturity distributions biased to the short end.
- Markets and institutions:
  - Money and interbank markets: shallow, short of instruments, structural excess liquidity, few instruments other than government paper; repurchase arrangements increasingly common.
  - Equity markets: for the 16 LICs with data, median stock market capitalization to GDP has more than doubled since the mid-1990s; liquidity remains low; median EM capitalization ~ three times that of LICs.
  - Bond markets: growth centered on primary markets and short-term government securities; some long-dated domestic currency issuance emerging; only a handful of LICs have developed secondary government security markets.
  - Institutional investors: most LICs exhibit insurance asset ratios below 2 percent of GDP (2007–2009); insurance premiums in the median LIC are about a third of EM values; pension industries are small and dominated by state schemes.
  - Foreign exchange markets: FX markets remain shallow and illiquid; fewer than 50 percent conduct forward transactions for hedging.
- Outreach and access:
  - Household access improved (deposit and loan accounts per thousand adults) but lags EMs.
  - Combining banks and MFIs, LICs have less than a quarter of the number of deposit accounts and a third of loan accounts of EMs per 1000 people.
  - Examples of very low access: Rwanda and Tanzania—10-15 percent of population has access to formal banking services; Burundi—less than 2 percent.
  - Firms: surveyed firms in EMs are about 1/3 as likely to report being credit-constrained (relative phrasing in source), and twice as many report having either a bank loan or a line of credit; bank credit in LICs largely finances working capital rather than fixed assets.
- Heterogeneity:
  - Substantial cross-country and regional heterogeneity: median LICs in SSA and MNA lag other regions; some LICs exceed EM medians in depth and efficiency.

### IV. Financial possibility frontier and determinants of gaps
- Financial possibility frontier (FPF) concept:
  - FPF is the upper limit of sustainable financial system depth, breadth, or reach at a given point in time.
  - Constraints arise from structural factors (income per capita, size, population density, economic concentration), policy and institutional variables (macroeconomic fundamentals, contractual frameworks), and exogenous influences (technology, conflict).
  - The structural depth line (SD) represents expected depth given structural characteristics; actual depth (D) can be above or below SD; the frontier can shift over time via technological and institutional advances.
- Country typology relative to the frontier:
  - Low possibility frontiers: structural/institutional characteristics render systems inherently shallow; fixed costs and scale effects limit local capital market development (examples: small island economies).
  - Systems below the frontier: demand-side constraints (low public confidence, self-exclusion) and supply-side constraints (macroeconomic environment, weak creditor information, collateral regimes, opacity, limited competition, regulatory restrictions).
  - Systems beyond the frontier: rapid expansion beyond oversight capacity can generate excessive risk-taking and fragility (credit and asset price booms in Nepal and Vietnam cited).
- Empirical benchmarking findings:
  - Benchmarks controlling for policy-invariant structural factors confirm low structural frontiers across financial indicators for LICs.
  - Despite low structural frontiers, the median LIC has deepened by more than expected from structural characteristics over the past decade, with wide variation across regions and indicators.
  - Regional contrasts: median LIC in Asia and LAC exceeded benchmarks for deposits and private credit to GDP; median LIC in SSA and CIS lagged benchmarks.

### V. Bank-level evidence on intermediation and lending gaps
- Stylized bank-level facts:
  - LIC banks lend less and hold larger shares of assets in government securities and foreign claims relative to benchmarks.
  - LIC banks charge higher interest margins and deploy a lower proportion of assets into lending compared with banks in other contexts.
- Drivers of margins and allocation:
  - Decomposition shows median operating costs in LIC banks are only slightly higher than in EMs; higher loan-loss reserves and higher profits (market power) explain much of margin differences.
  - Regression evidence: large market share and risk (credit risk and lower capitalization) are dominant factors in LIC banks; contractual framework efficiency explains a large share of variation in margins.
  - Smaller allocation to lending explained by insufficient scale and low credit portfolio quality; improvements in institutional quality mitigate moral hazard and adverse selection.

### VI. Episodes of deepening, thresholds, and risks
- Episode typology (sample of 105 countries, 1960–2009):
  - Stagnation episodes: little movement; about a third of observations.
  - Short accelerations: rapid, short-lived growth in private credit; about 20 percent.
  - Sustained accelerations: growth sustained for a decade or more; about 17 percent.
- Patterns and outcomes:
  - LICs exhibit more stagnation and short episodes, and significantly fewer long episodes than HICs and MICs.
  - Short accelerations frequently result in crises; the odds of a sustained growth episode ending in a banking, currency, or debt crisis are half those of short episodes.
  - The likelihood of a hard landing is twice as high in MICs compared to other countries.
  - Rapid and far-reaching financial liberalization associated with greater likelihood of an episode ending in crisis.
  - Initial conditions important: macroeconomic stability and policy/institutional settings in the 4-5 years preceding an episode strongly influence outcomes.
- Non-linear finance-growth nexus:
  - Threshold effects: the relationship between financial depth and growth strengthens as income rises.
  - LICs (particularly commodity exporters) obtain less of a growth dividend from existing depth than higher-income counterparts.

### VII. Policy lessons and recommended reforms
- Core policy lessons:
  - Macroeconomic stability is necessary for sustained deepening.
  - Financial liberalization fosters accelerations but yields sustained deepening mostly when strong institutions exist.
  - Rapid liberalization without supervisory capacity increases crisis risks; excessive credit growth can precipitate crises even in deeper systems.
  - Improvements in supervision raise the odds that liberalization leads to long accelerations rather than short, crisis-prone ones.
- Public policy roles:
  - Ensure macro stability (fiscal consolidation, central bank credibility) to encourage deposit mobilization and credit expansion.
  - Institutional and infrastructure reforms to overcome scale barriers (technological innovation, competition, regional cooperation in payments/settlement and bond markets).
  - Operational reforms to improve market micro-structure (primary dealers, auction systems, use of FX swaps/repurchase analogues).
  - Address information gaps: credit registries, collateral frameworks, well-targeted partial credit guarantees.
  - Remove distortions: eliminate compulsory lending and discriminatory tax/regulatory treatments that bias financing towards or away from specific instruments.
  - Risk oversight and management: widen supervisory perimeter as access broadens, calibrate liberalization speed to prudential capacity, strengthen cross-border supervision with greater foreign bank penetration, and enhance consumer protection where rapid access expansion occurs.
- Examples of reforms and innovations:
  - M-Pesa (Kenya, 2007) and Smart Money (Philippines, 2000) lowered costs and broadened payments access via flexible regulation.
  - Uganda and Tanzania introduced credit reference bureaus; Uganda used credit guarantee mechanisms for agricultural loans.
  - Turkey’s tax reforms and primary dealer framework increased government and corporate bond market depth.
- Macro-stability benefits of sustainable deepening:
  - Enhances price discovery and monetary transmission (e.g., Turkey, Georgia).
  - Reduces financing and rollover risks through domestic investor bases and longer maturities (Mexico, Uruguay, India, Korea).
  - Expands policy flexibility by reducing balance-sheet risks and dollarization pressures.

### VIII. Surveillance implications and operational proposals (paragraphs 40–47)
- Rationale for broader surveillance:
  - Financial sector surveillance should extend beyond bank soundness to include how the financial system affects policy effectiveness, resilience, and growth.
  - Bilateral surveillance should consider how a country’s financial system limits macro policy space and transmission.
- Minimum monitoring and indicators:
  - Monitor range of providers, markets and products; depth and liquidity of market segments; efficiency; reach and use of services; and degree of interconnectedness and scope for macro-prudential policy.
  - Minimum monitoring should include depth, liquidity, and functioning of foreign exchange, money, interbank, and government securities markets and the institutions that form them.
- Assessment tools:
  - Use benchmarking and the financial possibility frontier to inform judgments on potential areas for sustainable deepening.
  - Over-performance relative to benchmark could indicate either sound past policy or emerging vulnerabilities (e.g., credit boom).
- Data and capacity building:
  - A joint IMF-World Bank macro-financial data portal for LICs (internal use) established to integrate existing data sources, combine financial indicators with country-specific benchmarks, and synthesize qualitative information on policies and institutions.
  - Information gaps remain (money, FX, securities markets functioning; secondary market activity); TA is an important source of information and should be better integrated with macro-stability needs.
- Further analytical and operational efforts:
  - Pilot the surveillance approach in selected countries and develop a toolkit supplementing benchmarking with institutional and policy assessments.
  - Further research on causes and implications of financial system gaps, nexus between dollarization and deepening, and relations between financial policies, deepening, and growth.
  - Continue collaboration with the World Bank to leverage expertise and avoid duplication.
- Resource and organizational implications:
  - Mainstreaming this surveillance approach will have resource and organizational implications; staff will return to the Board with concrete proposals informed by pilot experience and considering scope for division of labor with the World Bank.

*Source: ENHANCING FINANCIAL SECTOR SURVEILLANCE IN LICs: FINANCIAL DEEPENING AND MACRO-STABILITY (excerptes from _041612).*

### References  _______________________________________________________________________________________  35

### _041612 - References  _______________________________________________________________________________________  35

### I. INTRODUCTION
- Context: global financial crisis and recent commodity price spikes highlighted LICs’ vulnerability to volatile external financing flows and sharp swings in the terms-of-trade.
- Financial deepening defined as a multidimensional process increasing:
  - efficiency (e.g., payments services);
  - depth (e.g., credit intermediation and market turnover);
  - breadth (e.g., range of markets and instruments);
  - reach (e.g., access) (Goyal et al., 2011).
- Benefits and risks: deepening can confer important benefits for macro-stability and sustained growth, while creating new risks from greater interconnectedness and unregulated innovation.
- Surveillance gaps:
  - Bilateral surveillance often focuses narrowly on banking soundness and solvency.
  - Comprehensive data on multiple dimensions of LIC financial systems are often missing.
  - FSAPs provide granularity but are low frequency and constrained by evolving LIC financial structures.
  - World Bank work on financial development has been insufficiently leveraged in macro policy advice.
- Purpose of the paper:
  - Widen financial sector surveillance lens in LICs to understand limits to policy implementation posed by shallow and undiversified financial systems.
  - Draw implications for analytical and operational issues; distill policy lessons from country experiences increasing depth, breadth, and reach.
  - Provide a new IMF-World Bank macro-financial data portal for LICs to encapsulate available information on multiple dimensions of LIC financial systems.
- Structure: Sections II–VI cover challenges, stylized facts, constraints to deepening, policy actions and case studies, and implications for surveillance. Two background studies provide supporting notes and case studies.

### II. MOTIVATION: CHALLENGES POSED BY SHALLOW MARKETS
- Core issue:
  - Underdeveloped financial systems in LICs provide inadequate shock absorption, amplifying macro-financial vulnerabilities from external shocks and hampering growth and poverty reduction.
  - Shallow systems constrain policy instruments, impede risk transfer, and engender adverse macro-financial feedback loops.
- Evidence and patterns:
  - New empirical analysis points to a U-shaped effect of financial depth on macroeconomic volatility, with depth amplifying volatility at very high levels beyond those observed in most LICs, implying scope for further deepening.
  - Average de facto financial globalization (gross external assets and liabilities) has increased six-fold since the mid-1980s, led by the “frontier markets.”
  - Example frontier markets listed: Mozambique, Senegal, Uganda, Tanzania, Bangladesh, Cote d'Ivoire. Ghana, Kenya, Nigeria, Vietnam, and Zambia.
- Policy-framework constraints and transmission channels:
  - Exchange rate regime: financial underdevelopment associated with higher likelihood of adopting fixed exchange rate regimes; de facto regimes in LICs remain less flexible compared to EMs.
  - Monetary policy: LICs are more likely to use direct instruments and rely on reserve requirements and statutory liquidity ratios; policy rate changes are less correlated with money market rates in LICs.
  - Fiscal policy: thin domestic debt markets and variable foreign financing leave little room for maneuver; fiscal policy tends to be more pro-cyclical in countries with underdeveloped financial systems.
- Financial stability implications:
  - Foreign currency risk: limited availability of currency forwards and hedges increases direct and indirect exposures and credit risk from currency mismatches.
  - Liquidity management: thin domestic money markets raise banks’ costs of adjusting liquidity and contribute to high liquid asset holdings and shorter asset maturities.
  - Concentration risks: narrow range of formal actors and limited diversification concentrate banks’ exposures and amplify credit and interest rate risks.
- Macro-financial interaction with capital flows:
  - Shallower markets have lower capacity to absorb inflows without large asset price and real exchange rate changes and can contribute to boom-bust cycles in credit and investment (FSB/IMF/World Bank, 2011).
- Implication: broaden financial sector surveillance in LICs to encompass interactions between financial deepening and macro-financial stability.

### III. STYLIZED FACTS: RECENT PATTERNS IN FINANCIAL DEEPENING
- Objective: document patterns of deepening across LICs and EMs, and within LICs, since the mid-1990s, covering markets and financial institutions to assess intermediation, allocation efficiency, and access.
- Empirical materials and figures referenced (selection):
  - Figure 1: Shock Frequency and Welfare Impacts in LICs.
  - Figure 2: Foreign Bank Ownership and Financial Sector Reforms in LICs.
  - Figure 3: Banking System Deepening in LICs and EMs, 1996-2009.
  - Figure 4: Private Credit, Institutional Quality, and Financial Integration, 2000-2009.
  - Figure 5: Financial Markets and Institutional Investors in LICs.
  - Figure 6: Benchmarking Financial Development in LICs.
  - Figure 7: Partial Influence Functions of Banking Depth and Growth.
  - Figure 8: Likelihood of Financial Deepening Episodes, Given Initial Conditions.
  - Figure 9: Illustrative Framework for Financial Sector Surveillance in LICs.
- Key summary points:
  - Financial deepening in LICs remains incomplete across depth, breadth, and reach dimensions, with substantial heterogeneity across countries.
  - Deeper financial systems can reduce volatility of investment and consumption by alleviating liquidity constraints and enabling intertemporal smoothing, but deepening must be managed to contain new risks.
  - Data limitations and low-frequency diagnostic tools constrain full assessment of LIC financial development, motivating the IMF-World Bank macro-financial data portal initiative.

*ENHANCING FINANCIAL SECTOR SURVEILLANCE IN LICS: FINANCIAL DEEPENING AND MACRO-STABILITY, INTERNATIONAL MONETARY FUND*

### 13.      Backdrop. The environment in which LIC financial systems operate has changed radically

### 13.      Backdrop. The environment in which LIC financial systems operate has changed radically

### Ownership, reforms, and regulatory environment
- Better policy and economic management, wide-ranging financial sector reforms, a favorable external environment in the run-up to the global crisis, and ample global liquidity have fostered financial sector development.
- Many LIC banking systems shifted away from pervasive state interventionism toward privately-owned systems, often controlled by foreign banks.
- Foreign bank penetration has more than doubled for the median LIC since 1995, and is particularly high in Sub Saharan Africa (SSA).
- Regional integration patterns reflected growing foreign bank presence (e.g., increasing importance of South African and Nigerian banks in SSA; Malaysian and Singaporean banks in Vietnam and Cambodia).
- Many LICs eliminated interest ceilings and other restrictions since the 1990s, at a pace similar to EMs.
- Stronger regulatory and supervisory frameworks contributed to lower incidences of banking crises in the 2000s, although pockets of fragility persist.

### Financial structure
- LIC financial systems remain largely bank-based; banks act as the main players in payments, money and foreign exchange markets, and dominate government securities markets.
- Stock market capitalization in LICs represents a fraction of private credit extended by the banking system.
- The nonbank financial intermediary and microfinance sectors (MFIs) are growing.
- The banking system continues to account for over 80 percent of financial system assets in the median LIC.

### Banking system trends and indicators
- LIC banking systems have deepened over the past two decades, albeit from a low base.
- Median growth of credit to the private sector in LICs has doubled since the mid-1990s.
- Deposit mobilization has grown at an even more rapid pace than credit, resulting in declining loan-to-deposit ratios.
- Interest margins and spreads in LICs have declined since the mid-1990s, but remain wide compared to EMs.
- LIC banking systems, particularly in SSA, Latin American and the Caribbean (LAC) and Middle East and North Africa (MNA), tend to be concentrated compared to EMs.
- Banks tend to offer more basic payment and credit services, with maturity distribution of deposits and loans biased toward the short end.

### Heterogeneity across LICs
- Large variation in observed patterns of deepening: some LICs exceed the EM median in depth and efficiency; others have experienced virtually no deepening.
- Significant regional variation: median LIC in SSA and MNA lag other regions.
- Structural features influencing deepening: commodity exporter status, size, degree of financial integration, and legal/institutional frameworks.
- Median values for the ratio of private credit to GDP are comparable for more financially integrated LICs and EMs, and those with better quality of governance.

### Financial markets and other institutions
- Financial markets remain smaller, less liquid, and provide a narrower range of services compared with EMs.
- Money (and interbank) markets:
  - Money markets in LICs are shallow, short of instruments, and poorly structured.
  - Structural excess liquidity encourages buy-and-hold strategies by banks; some banks are excluded because of counterparty risk.
  - Constraints on market-determined rates with few instruments other than government paper; repurchase arrangements are becoming increasingly common.
- Equity markets:
  - For the 16 LICs with data, median ratio of stock market capitalization to GDP has more than doubled since the mid-1990s, led by frontier markets and reflecting high valuations.
  - Liquidity remains low and access is concentrated in a few enterprises; banks and nonbank financial institutions constitute a large share of listings.
  - Median EM capitalization was around three times that of LICs, with significantly higher turnover.
  - Shallowness renders LIC equity markets susceptible to sudden price movements and greater disruption.
- Bond markets:
  - Bond markets increased in size but are mostly centered on primary markets and concentrated in short-term government securities.
  - Increasing issuance of long-dated domestic currency government bonds in some LICs.
  - International sovereign bond issuances have increased; private external bond issuance limited to a few countries (e.g., Vietnam, Mongolia, and Bangladesh).
  - Only a handful of LICs have developed secondary government security markets.
- Institutional investors (insurance, pension, mutual funds):
  - Based on data for 2007-2009, most LICs exhibit insurance asset ratios below 2 percent of GDP.
  - A small number of LICs (e.g., Kenya, Vietnam, and Bolivia) have insurance assets exceeding the EM median.
  - Insurance premiums as a share of GDP in the median LIC are about a third of the values in EMs.
  - Pension industry in most LICs is small and dominated by state-owned schemes (Kenya notable exception), with portfolios concentrated in short-term fixed-income instruments (e.g., government bonds and bank deposits).
- Foreign exchange markets:
  - Case study evidence suggests FX markets in LICs remain shallow and illiquid.
  - FX markets in LICs have much lower turnover compared with EMs; fewer than 50 percent conduct forward transactions for hedging.

### Outreach and access
- Financial systems’ shallowness is reflected in limited access to financial services by households and enterprises.
- Household access to financial services:
  - Use of banking services by households has improved as proxied by number of deposit and loan accounts per thousand adults, but continues to lag EMs.
  - MFIs are growing rapidly but are far from filling gaps in banking service use.
  - Even combining deposit ownership in banks and MFIs, LICs have less than a quarter of the number of deposit accounts and a third of loan accounts of EMs per 1000 people.
  - Significant regional variation: LICs in MNA and SSA trail other regions, particularly in credit service use.
- Firm access to financial services:
  - Firms’ access to external finance is more limited in LICs than in EMs (World Bank Enterprise Surveys).
  - Surveyed firms in EMs are about 1/3 as likely to report being credit-constrained (relative phrasing in source), and twice as many report having either a bank loan or a line of credit.
  - Large firms report lower credit constraints than SMEs in most countries.
  - Firms in MNA and SSA LICs tend to be most credit-constrained.
  - Bank credit in LICs is largely used to finance working capital rather than fixed assets, suggesting obstacles to firm expansion.
  - The gap in use of credit between firms of different sizes is larger in LICs than elsewhere, hampering their contribution to growth.

### Summary and implications
- Financial systems in LICs have grown and inclusion has broadened, but they remain small and relatively undiversified.
- Considerable scope for further deepening to reap macro-stability and growth benefits.
- Sizeable cross-country heterogeneity points to differing areas and approaches for deepening:
  - For some LICs (e.g., frontier markets), main challenge is to enhance macroeconomic policy effectiveness by sustainably deepening capital markets, encouraging long-term investing, and strengthening financial oversight.
  - Other LICs have gained little in depth or diversity, with rudimentary financial systems and a large reform agenda to address macro-financial vulnerabilities.
  - In yet other LICs, broadening financial inclusion (access to savings, credit, payment services, and SME financing) remains a critical policy challenge.

### Impediments to deepening — scope for deepening and challenges
- Scope for deepening:
  - Potential reflects ease of ameliorating market frictions, policy choices, and synergies across financial system segments.
  - Captured by the concept of a financial possibility frontier: the upper limit of sustainable financial system depth, reach, or breadth at a given point in time.
  - Constraints arise from structural factors (income per capita, size, population density, economic concentration), policy and institutional variables (macroeconomic fundamentals, contractual frameworks), and exogenous influences (technology, conflict).
- Challenges taxonomy depending on country standing relative to its frontier:
  - Low possibility frontiers:
    - Structural and institutional characteristics render some LIC financial systems inherently shallow and largely invariant to short-to-medium-term policy changes.
    - Fixed costs in financial service provision explain why larger LIC economies (e.g., Vietnam, Bangladesh, Nigeria, and Kenya) can sustain more diversified systems than peers; many small island economies have shallow systems.
    - Scale effects in payments, settlement infrastructure, regulation, and network effects mean not all LICs can develop local capital markets.
    - Low income levels, high informality, and low population density increase costs and risks, excluding large population segments from formal financial services (e.g., Rwanda and Tanzania: 10-15 percent of population has access to formal banking services; Burundi: less than 2 percent).
    - Economic concentration constrains domestic diversification; weak legal and judicial frameworks increase contracting risks.
  - Systems below the frontier:
    - Demand-side constraints can depress deposit mobilization (e.g., legacy of low public confidence in banks in Tajikistan and the Kyrgyz Republic) or limit loan applicants due to self-exclusion (financial illiteracy, high fees/documentation in many SSA LICs).
    - Supply-side constraints include macroeconomic environment, regulation, lack of reliable creditor information, weak collateral regimes (scope, registration, enforcement), opacity of financial information, weak corporate disclosure, limited competition, and regulatory restrictions.
    - Example: In Nigeria, regulatory barriers favoring equity issuance over debt securities and tax distortions have hampered corporate bond market development.
  - Systems beyond the frontier:
    - Rapid expansion beyond oversight capacity can generate excessive risk-taking and fragility.
    - Credit and asset price booms (e.g., Nepal and Vietnam) illustrate risks of unsustainable expansions in environments with weak regulatory/supervisory frameworks, poor accounting/disclosure, and deficient early warning and resolution systems.
    - Access to international markets and financial innovation can foster rapid deepening but also raise exposures.
    - Fragility often linked to governance problems and limited supervisory capacity and market discipline.

*International Monetary Fund*

### 22.      Policy and institutional gaps. A country’s standing relative to its structural depth frontier

### 22. Policy and institutional gaps. A country’s standing relative to its structural depth frontier

### Financial Possibility Frontier: concept and implications
- The financial possibility frontier defines the maximum sustainable level of financial system depth, breadth, or reach achievable at a given point in time.
- Financial deepening is limited by the interplay between:
  - transactions costs (e.g., fixed costs creating economies of scale) and
  - risks, both systemic and idiosyncratic (e.g., agency frictions).
- “State” variables constrain financial systems:
  - Structural characteristics: level of income, population size and density, age, dependency ratios.
  - Policy factors: macroeconomic stability, institutional and contractual frameworks underpinning financial activity.
  - Exogenous factors: available technology and socio-political conditions (e.g., conflict).
- The structural depth line (SD) represents expected depth given a country’s structural characteristics. Actual depth (D) can be above or below SD depending on policy performance.
- The possibility frontier is the maximum sustainable depth; policy improvements can move countries toward the frontier (D*), but some policy mixes may produce unsustainable depth beyond the frontier (e.g., credit boom-bust cycles).
- The frontier can shift over time via technological advances (e.g., mobile banking), institution building, legal and contractual upgrades, and improvements in information frameworks (e.g., credit registries).

### Evidence from benchmarking LICs
- Benchmarks that control for policy-invariant structural factors provide approximations to the structural depth frontier.
- Application to LICs confirms low structural frontiers across financial indicators.
- Despite low structural frontiers, the median LIC has deepened by more than expected from structural characteristics over the past decade, though performance varies widely across regions, countries, and indicators.
- Regional contrasts (examples):
  - The median LIC in Asia and LAC exceeded benchmarks for deposits and private credit to GDP.
  - The median LIC in SSA and CIS lagged behind benchmark levels for deposits and private credit to GDP.
- Specific empirical inputs and series referenced in figures and text:
  - Stock Market Capitalization, 2009 (In percent of GDP).
  - Insurance Premiums (Life & Non-Life), 2009* (In percent of GDP).
  - Commercial Banks' Accounts Per Thousand Adults, 2004-2009.
  - Domestic Bank Deposits, 2000-09 (In percent of GDP).
  - Private Credit, 2000-09 (In percent of GDP).
  - Source dataset: World Bank FinStats (2011).

### Explaining gaps: determinants and empirical findings
- Macro stability and policy reforms:
  - A stable macroeconomic environment (as proxied by lower inflation) is associated with lower gaps in private bank credit and tighter interest rate margins and with greater success in closing gaps over time.
  - Sound financial reform—loosening onerous controls on credit and interest rates, facilitating entry of new domestic and foreign institutions, permitting international capital flows, strengthening prudential regulation, and undertaking policies conducive to securities market development—is associated with lower credit gaps.
  - Financial crises can have persistent negative effects on banking system depth by worsening banks’ and borrowers’ balance sheets.
- Enabling environment and institutional quality:
  - Poor governance and weaknesses in institutional, informational, and contractual facets are responsible for part of aggregate banking and equity market gaps.
  - Strengthening regulatory and supervisory apparatus encourages sound decision-making and can play a pivotal role in closing banking gaps.
- Ownership and market structure:
  - Greater banking competition, limited and arms-length state bank presence, and ease of entry of new institutions are associated with lower gaps and larger reductions in gaps over time.
  - Lack of competition remains a key impediment preventing intermediation costs from declining in LICs.

### Bank-level evidence on efficiency and lending gaps (Box 2)
- Stylized facts:
  - Banks in many LICs lend less than in other economies and, relative to benchmarks, hold larger shares of assets in government securities and foreign claims.
  - LIC banks charge higher interest margins and deploy a lower proportion of assets into lending compared with domestic banks in other contexts.
- Drivers of intermediation costs and lending (LICs vs EMs):
  - Decomposition of interest margins:
    - Median operating costs in LIC banks are only slightly higher than in EMs (though some SSA studies find high operating costs matter).
    - LIC banks have a higher share of loan-loss reserves, indicating riskier environments.
    - Higher profits account for the bulk of the explained difference in margins between LIC and EM banks, reflecting significant market power.
  - Regression findings:
    - Large market share and risk (credit risk and lower bank capitalization) are dominant factors in LIC banks compared with EMs.
    - The efficiency of the contractual framework—measured by an aggregate indicator of institutional quality—accounts for a large share of bank-level variation in interest margins in LICs.
  - Allocation to lending:
    - Smaller allocation of banks’ total assets to lending in LICs is explained by insufficient scale (size) and low credit portfolio quality, highlighting moral hazard and adverse selection problems mitigated by stronger institutional quality.
- Graphical and contribution indicators cited:
  - Contribution of Bank-Specific Determinants (Market share; Operating costs; Risk aversion; Credit risk; Liquidity; Size) shown in percent of total for LICs and EMs.
  - Contribution of Country-level Determinants in LICs (Institutional Quality; Entry Restrictions; GDP Growth) shown as impact of one standard deviation change.
  - Data source: Bankscope and author’s calculations.

### Impediments, growth dividends, and threshold effects
- Non-linear finance-growth nexus:
  - Empirical analysis points to threshold effects: the relationship between financial system depth and growth strengthens as the income level rises.
  - LICs (particularly commodity exporters) tend to obtain less of a growth dividend from their existing levels of depth than higher-income counterparts.
- Mitigating lower growth dividends:
  - Improving financial sector policies (e.g., strengthening bank regulation and supervision; addressing factors that held back financial deepening) can mitigate lower growth dividends.
- Implication:
  - Financial deepening should remain a key component of pro-growth strategy, with emphasis on the quality of intermediation and efficient allocation of funds to productive uses.
- Figures referenced:
  - Partial Influence Functions of Banking Depth and Growth (95 percent confidence intervals), showing:
    - The impact of Private Credit on Growth at different income levels (Log-Income scale).
    - The marginal impact of Private Credit on Growth in LICs at different levels of Bank supervision.

### Anatomy of financial deepening and episode typology
- Data and sample:
  - Analysis based on credit-to-GDP ratio for a sample of 105 high-, middle-, and low-income countries over 1960-2009.
- Three distinct patterns of financial deepening:
  - Stagnation episodes: little movement in deepening over long periods.
  - Sustained accelerations: growth in private credit picks up in a specific year and is maintained for a decade or more.
  - Rapid, but short-lived accelerations: growth in private credit halts in a number of years (typically less than 10); can end in a soft landing (deceleration to pre-growth levels) or a hard landing (financial crisis).
- Frequency (expressed in percentage of years of observations):
  - Stagnations represent about a third of the entire sample.
  - Short accelerations represent about 20 percent.
  - Long (sustained accelerations) represent about 17 percent.
- Income- and region-specific patterns:
  - HICs and MICs exhibit similar distributions for the three episode types.
  - LICs are characterized by more stagnation and short episodes, and significantly fewer long episodes.
  - By region, MNA and SSA have undergone the smallest number of sustained growth episodes.
- Stylized facts on drivers and outcomes:
  - Initial conditions:
    - Macroeconomic stability (low inflation) and high economic growth foster financial take-offs—particularly evident for countries that attained MIC status.
    - Short and long episodes respond to financial liberalization efforts, but not invariably.
    - Improvements in banking supervision were a driving force for sustained deepening.
    - Natural resource wealth does not spur sustained financial deepening.
  - Duration:
    - Short accelerations take off in a variety of environments; long accelerations are more likely with stronger institutions.
    - Stagnation episodes are common and may follow past sustained accelerations.
  - Terminal conditions:
    - Short accelerations frequently result in crises.
    - The odds of a sustained growth episode ending in a banking, currency, or debt crisis are half of those of short episodes.
    - The likelihood of a hard landing is twice as high in MICs compared to other countries.
    - Accelerations ending in a financial crisis are more likely in countries with macroeconomic instability—where, in the five years preceding the acceleration, inflation and real interest rates are high relative to peers.
    - Rapid and far-reaching financial liberalization is associated with a greater likelihood that an episode will end in a crisis.
    - Gains from financial deepening episodes can be reversed; sustained deepening episodes have later regressed, most frequently due to war, political conflict, or financial crises.

*Source: 22. Policy and institutional gaps. A country’s standing relative to its structural depth frontier.*

### 29.      Policy considerations. A number of general policy lessons can be drawn from this analysis.

### 29.      Policy considerations. A number of general policy lessons can be drawn from this analysis.

### Key policy lessons
- Macroeconomic stability is an important ingredient for sustained deepening, echoing the findings from the gap analysis in the previous section.
- Financial liberalization is strongly linked to financial accelerations, but liberalization is more likely to lead to sustained periods of deepening in the presence of strong institutions.
- Deepening is related to crisis incidence: rapid, insufficiently supervised liberalization is associated with higher crisis risks.
- Excessive credit growth can precipitate crises even if the financial sector is deep; the higher incidence of short accelerations resulting in crises in MICs reflected excessive risk-taking and lagging regulatory and supervisory capacities.
- The likelihood of a long acceleration increases in the wake of financial liberalization if accompanied by improvements in supervision.
- These findings underscore the importance of commensurate strengthening of regulatory and supervisory frameworks to minimize risks arising in the deepening process.
- Initial conditions are determined 4-5 years preceding the start of an episode.

### Role of public policy in facilitating deepening: coverage and context
- Policy plays an important complementary role in facilitating financial deepening by:
  - Ensuring stable macroeconomic environments.
  - Implementing institutional and infrastructural reforms that create an enabling framework for markets and private initiatives.
  - Enacting regulatory and oversight policies to address inefficiencies and risks generated by markets and market players.
- Case studies focus on increasing depth (e.g., credit intermediation), breadth (e.g., range of markets and instruments), and reach (e.g., inclusion), while managing attendant risks.

### Caveats
- Financial deepening paths may not be replicable across countries due to unique macroeconomic, institutional and structural conditions, leapfrogging, and financial crises.
- Considerable heterogeneity within LICs implies that reforms’ relative importance and cost-benefit tradeoffs can differ widely across countries and over time; country-specific circumstances and institutions must be accounted for.

### Fostering macroeconomic stability
- Preconditions:
  - Macroeconomic stability is a necessary condition for unlocking the financial deepening process, as shown by experiences in transition economies and other EMs (e.g., Mexico and Turkey).
  - In transition economies, deposit mobilization and credit expansion only took off when disinflation became entrenched.
  - In Mexico and Turkey, consolidation of fiscal positions, greater central bank autonomy, and ensuing disinflation enhanced policy credibility and reduced uncertainty over investment returns, encouraging demand for financial assets.

### Public policy for institutional reform and infrastructure
- Overcoming scale barriers:
  - Interventions supporting technological innovation, promoting competition (e.g., reducing onerous licensing/branching restrictions, easing discriminatory regulatory constraints for banks/non-bank entities), and creating infrastructures (e.g., regional bond market initiatives, cooperation in payments and settlements networks) help achieve economies of scale and reduce costs.
  - Examples:
    - M-Pesa in Kenya (2007) and Smart Money (2000) in the Philippines: financial innovation supported by flexible regulation lowered costs and broadened access to payments services, facilitating integrated mobile-based payments services and banking products (e.g., M-Kesho linking banks with mobile operators).
    - Uganda: enabling legislation for microfinance and savings and credit cooperatives (SACCOs), supported by central government funding and credit subsidies, spurred access to financial services, but raised concerns about proliferation, distortion from government support, and directed lending.
    - ASEAN and WAEMU: use of international exchanges and cooperative solutions, lowering cross-border barriers, creation of harmonized market infrastructure (e.g., clearing and settlement, credit rating, trading arrangement, risk mitigation) fostered non-bank finance and regional bond market development; initial central bank financing for diversified funds helped facilitate regional bond market development in the ASEAN.
- Operational reforms:
  - Improving market micro-structure facilitates price discovery and market development.
  - Examples:
    - Nepal: strategy to improve liquidity management included organizational arrangements for better public debt management and auctions of government securities.
    - Kyrgyz Republic: used foreign exchange swaps as an analogue to repurchase agreements while developing marketable government securities (e.g., by securitizing government debt in the central bank’s portfolio).
    - Turkey: primary dealers in government securities acted as market-makers in the early 2000s, increasing liquidity in the secondary market.
- Addressing information gaps:
  - Strengthening informational and contractual frameworks (e.g., credit registries, collateral, risk insurance) and supporting market infrastructure can foster deepening.
  - Well-targeted partial credit guarantee schemes can address market failures where credit information and creditor rights are weak.
  - Examples:
    - Effective collateral regimes require well-established property rights (titling, registration, security of land tenure); U.S. example: communal land released through enabling legislation allowed land to be used as mortgage collateral in Native American communities.
    - Uganda and Tanzania introduced credit reference bureaus to collect and distribute borrower information, limit over-borrowing and facilitate competition (access by MFIs remains limited). In Uganda, credit guarantee mechanisms enabled risk sharing for agricultural loans, leasing and innovative collateral (e.g., dated checks, equipment).
    - Botswana: credit life insurance, though very expensive, was required by banks for all loans to individuals; given widespread HIV/AIDs, this allowed access to credit to those who may otherwise have been excluded.
    - South Korea (1980s): promoted brokers and dealers for call transactions to reduce segmentation arising from lack of credit information; Turkey: central bank acted as a blind broker counterpart for all transactions, borrowing only when it could on-lend at the same interest rate.
- Removing distortions:
  - Eliminating inefficient regulations and compulsory lending policies can positively impact market development.
  - Examples:
    - Mexico: development of the government bond market was spurred by elimination of compulsory lending to the government by banks.
    - Turkey: tax reform (e.g., elimination of withholding tax on income from bonds with maturities of over five years and reducing the tax rate on those with maturities of less than five years) and greater transparency increased appetite for corporate bonds.
    - India: removal of entry restrictions in the insurance sector, accompanied by supporting regulation, encouraged greater deepening (state-owned firms remain dominant).
    - Barbados: limited restrictions on asset composition of insurance companies allowed the industry to supply mortgage finance until banks became more active.

### Public policy for risk oversight and management
- Managing risks:
  - Proactive oversight, continuous risk monitoring, and mitigation of systemic risks are essential to reap deepening benefits.
  - Regulatory and supervisory frameworks must keep up with market deepening to avoid new sources of risk and instability.
  - Key points and examples:
    - Broadening access requires widening the regulatory and supervisory perimeter to minimize regulatory arbitrage and system risks; operational risk concerns have arisen in Uganda, Kenya and the Philippines where branchless banking blurred distinctions between banks and non-bank institutions.
    - Rapid expansion of non-bank intermediaries, traditionally outside regulatory remit and increasingly interconnected with banks, can pose financial stability challenges.
    - Pace of financial liberalization should be calibrated to prudential oversight capacity: in Mexico (build-up to the Tequila crisis), liberalization with poor oversight resulted in asset-liability mismatches, concentrated market risk and excessive related-party lending. Uruguay’s experience after the Argentine crisis shows wide-ranging liberalization without adequate prudential and supervisory infrastructure can lead to concentrated cross-border exposures, bank runs and illiquidity.
    - Greater foreign bank penetration increases the importance of cross-border supervisory cooperation and information sharing. Uruguay strengthened cross-border regulation in 2002-03 so subsidiaries and branches of foreign banks and offshore offices were subject to the same prudential, inspection, and regulatory reporting requirements as domestic banks.
    - Aggressive policies to broaden access can increase consumer indebtedness and require stronger consumer protection: aggressive consumer credit expansion by small-scale lenders in Uganda poses challenges for rural indebtedness; in South Africa, credit life insurance provided access but charged excessively high premiums, prompting the introduction of consumer credit regulation in 2006.

### Macro-stability benefits of sustainable deepening
- Financial sector policies fostering sustainable deepening can:
  - Enhance price discovery.
  - Facilitate macroeconomic policy responsiveness.
  - Enhance shock absorption capacity.
  - Break up mono providers of financial services, allowing more effective credit allocation, reduced costs, greater inclusion, and improved payments services.
- Examples:
  - Enhancing monetary transmission:
    - Deeper interbank, money, and debt markets have improved monetary operations (e.g., primary dealers in government securities auctions in Turkey provided two-way price quotes, improving price discovery and transmission).
    - Georgia: greater market depth allowed benchmarking and better debt management through a yield curve across a wide range of maturities.
  - Reducing financing risks:
    - Deep and diversified financial systems can reduce financing risks and stabilize government financing sources.
    - Mexico and Uruguay: improved macroeconomic fundamentals, stringent prudential measures, and increased reliance on domestic currency financing with longer maturities (supplied by domestic investors) helped mitigate rollover and exchange rate risks.
    - Growing presence of domestic institutional investors helped secure longer-term and stable financing bases in Mexico, Turkey, India, Barbados, Brazil and Korea.
    - Regional bond market development in Asia helped diversify and stabilize financing; however, regional integration can generate systemic risk (e.g., Euro area crisis, 2010 crisis in Côte d’Ivoire affecting WAEMU countries).
  - Fostering policy flexibility by reducing balance sheet risks:
    - Measures to enhance market stability and limit dollarization have reduced balance sheet risks and expanded exchange rate regime choices (e.g., Turkey post 2000 crisis: fiscal stabilization allowed development of domestic debt markets, helping the Treasury reduce its share of foreign currency denominated debt).

### Conclusion
- Many impediments to financial deepening in LICs reflect underlying structural features (size, scale, economic concentration) rather than unique obstacles.
- The policy reforms documented are neither exhaustive nor universally replicable, but targeted and balanced initiatives can help overcome specific impediments:
  - Encourage competition.
  - Develop information infrastructure.
  - Address collateral issues.
  - Limit excessively intrusive public sector interventions and public dominance.
- Reforms can create positive externalities where specific actions catalyze emergence of other market segments.
- Maintaining sound macroeconomic conditions and vigilance to emerging risks are necessary to reap deepening benefits.
- A balance is required: regulation should foster prudent market conduct without unduly hindering deepening — too rapid deregulation risks instability, while highly restrictive rules may hinder financial deepening.
- With sufficient progress in deepening selected market segments, there are positive implications for policy effectiveness and capacity to respond to shocks.

*Source: _041612 - 29.      Policy considerations. A number of general policy lessons can be drawn from this analysis.*

### 40.      Surveillance. The critical relevance of financial sector deepening for macro-financial

### 40.      Surveillance. The critical relevance of financial sector deepening for macro-financial stability and sustained growth in LICs

### 40–42: Rationale for broadening financial sector surveillance in LICs
- The Fund’s financial sector surveillance should broaden beyond a narrow focus on banking system soundness and solvency to account for the broader role of the financial system in engendering strong, durable growth, including through greater resilience and capacity to withstand shocks. (paragraph 40)
- Bilateral surveillance in LICs should be augmented to consider how a country’s financial system limits macroeconomic policy space and effective policy transmission and implementation. (paragraph 40)
- Keeping abreast of risks arising from financial deepening allows policy makers to tackle attendant vulnerabilities and better harness the benefits of deepening. (paragraph 40)

### Providing context (paragraphs 40–41)
- A tailored, country-specific approach is essential given the considerable diversity within LIC financial systems. (paragraph 40)
- Stocktaking dimensions to chart progress with financial deepening include: depth, diversity, access, degree of interconnectedness, operational effectiveness, and oversight. (paragraph 40)
- Benchmarking and diagnostics can:
  - Discern where a country’s financial system stands in relation to peers.
  - Identify which financial services are underprovided and which sub-segments or instruments appear underdeveloped. (paragraph 40)

### Indicators and minimum monitoring (paragraph 41)
- Surveillance should go beyond financial soundness indicators to consider and understand:
  - (i) the range of providers, markets and products available to diversify the financing base;
  - (ii) the depth and liquidity of different segments of the financial system to absorb shocks;
  - (iii) the efficiency with which institutions and markets work;
  - (iv) reach of the financial system and use of financial services by households and enterprises; and
  - (v) the degree of financial interconnectedness and scope for macro-prudential policy. (paragraph 41)
- Minimum monitoring should include the depth, liquidity, and functioning of key markets—foreign exchange, money, interbank, and government securities markets—and the institutions that make up those markets. (paragraph 41)
- Not all indicators will be available or germane for all countries; focus should be on constraints holding back development of segments that assist policy effectiveness and resilience. (paragraph 41; refers to Supplement I, Chapter I0)

### Assessment tools (paragraph 42)
- Benchmarking against peers or regional averages is a straightforward approach to assess financial deepening progress but does not systematically unbundle structural and policy factors. (paragraph 42)
- The financial possibility frontier and the structural benchmarking exercise in Section IV are proposed tools to inform judgment on potential areas to facilitate sustainable financial deepening. (paragraph 42)
- Policy recommendations should vary depending on a country’s position relative to its structural benchmark:
  - Under-performance relative to expected value can identify gaps in the enabling environment.
  - Over-performance relative to the benchmark could reflect past sound policies or could flag emerging vulnerabilities (e.g., a credit boom). (paragraph 42)

### 43–44: A broader view on policies and monitoring
- Financial sector policies should be informed by how absence or limitations of intermediaries, markets, and enabling policies affect policy implementation and macro stability in LICs. Monetary and fiscal policy advice cannot be treated in isolation from institutional and market infrastructure supporting monetary transmission, debt management, and fiscal financing. (paragraph 43; references Supplement I, Chapter V)
- Identifying underlying bottlenecks and the policies required to address them is essential; their relative importance varies across financial services/markets. (paragraph 43)
- Monitoring should include evaluation of regulatory and supervisory frameworks and financial sector policies to support and keep pace with financial deepening. (paragraph 44)
- Risks arise when financial sector expansion occurs without commensurate strengthening of regulatory and supervisory infrastructure. (paragraph 44)
- Supervisory arrangements appropriate to LIC peculiarities (e.g., economic concentration) may need consideration in conjunction with standard-setters. (paragraph 44)
- Surveillance should consider repercussions of inadequate supervisory resources—one of the most frequent FSAP findings—and how to address such capacity constraints. (paragraph 44)
- Figure 9 provides an illustrative schematic of the proposed framework for surveillance. (paragraph 44)

### 45–46: Addressing information gaps and ongoing data efforts
- Limitations in financial sector data availability constrain financial sector surveillance in LICs; a new joint IMF-Bank macro-financial data portal for LICs (for internal use only) has been established to improve coverage and dissemination of financial indicators by better integrating existing data sources. This portal:
  - Was established by the Fund-Bank LIC Financial Group under the auspices of the Financial Sector Liaison Committee (FSLC). (paragraph 45)
  - Combines a comprehensive list of financial indicators that provide granularity for assessing financial deepening in LICs with country-specific benchmarks, synthesizing information collected by both institutions. (paragraph 45)
  - Disseminates quantitative indicators and provides a platform for sharing qualitative information on country policies, regulations, institutions, and arrangements for fostering an enabling environment. (paragraph 45)
- Existing data accessible to the Fund can advance implementation of the surveillance approach, but further efforts are needed to augment and widen access to information. (paragraph 45)
- Information gaps to be addressed include the functioning of money, foreign exchange, securities markets, and secondary market activity; gaps reflect lack of documented market descriptions and unavailability of comprehensive, consistent data. (paragraph 46)
- For more financially integrated LICs with systems similar to EMs, efforts are needed to systematically collect and report data on evolving financial interconnectedness. (paragraph 46)
- Technical assistance (TA) is an important potential source of information about financial system operations; better integrating TA policy advice with macro-stability needs could help address impediments to deepening in specific areas. (paragraph 46)

### 46: Further analytical and operational efforts proposed
- Pilot cases/toolkit:
  - Pilot the outlined approach in a few cases to discern how sustainable financial deepening could enhance macroeconomic policy effectiveness and implementation.
  - Develop a toolkit to supplement benchmarking with institutional and policy assessments, accounting for country circumstances (e.g., state of market infrastructure, degree of interconnectedness). (paragraph 46)
- Analytics:
  - Further research is warranted to examine causes and implications of financial system gaps, including private equity and institutional investors, and to understand when financial deepening is sustainable or signals risks.
  - Explore the nexus between dollarization, deepening, and macroeconomic policy effectiveness and the role of economic diversification.
  - Further examine relationships between financial sector policies, deepening, and growth. (paragraph 46)
- Collaboration with World Bank:
  - The approach is intended to complement, not duplicate, the World Bank’s work on causes of financial system gaps.
  - Continued collaboration with the World Bank is warranted, including exploring possibilities for leveraging expertise. (paragraph 46)

### 47: Resource and organizational implications
- Mainstreaming the work in surveillance will likely have resource and organizational implications.
- Staff will return to the Board with concrete proposals on these aspects in due course, informed by pilot experience and considering scope for division of labor/burden sharing with the World Bank. (paragraph 47)

*Source: Excerpt from "ENHANCING FINANCIAL SECTOR SURVEILLANCE IN LICs: FINANCIAL DEEPENING AND MACRO-STABILITY", sections 40–47.*

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